Currency Conundrum: Which way for Zim?

Joseph MverechaThere is an interesting debate on currency, in terms of way forward or more precisely a continuation of the debate, which has been going on over the past several months, in respect of currency.

The Hon. Minister of Finance and Economic development last week highlighted that “Zimbabwe was considering currency reforms”, noting that serious discussions were underway in respect of currency reforms.

Last week in Bulawayo, the CEO Africa Roundtable held a Conference where experts and policy makers extensively discussed various proposals, the merits and demerits thereof. On the other hand, several business organizations are at different stages of distilling their own recommendations, both short term and long term proposals. That is good.

No doubt, Monetary Authorities, and Treasury, most likely by now have a proposal or framework for currency reforms to be implemented at some appropriate time in the near future.

Most likely Authorities are planning for the most optimal currency reforms process, such as will ensure no disruption to economic activity, while at the same time rebalancing the economy.

The Making of a National Currency

The debate on currency has been and continues to be focused on what are the emblems that can underpin the acceptability of a currency, for its viable adoption and use in the domestic economy.

Hence the exalted focus on whether the currency should be backed by gold or some commodity or adoption of a Currency Board – as it were focusing on the pillars that are required for currency viability. Necessarily so. Significantly, these emblems or pillars may not be the core or fulcrum of the currency issue. They are important pillars but not necessarily the anchor for currency viability.

Reminds one of how the French military hierarchy and the public completely put their faith in the strength of the Maginot line, as a bulwark against Germany invasion in the years immediately preceding the outbreak of the Second World War.

The Maginot line! The Maginot line! We will stop the German army at the Maginot line! — was the patriotic fervour so frequently repeated by all French and sundry. The Maginot line was a series of fortifications and concrete obstacles built by the French War Minister Andre Maginot, along the border with Germany, Luxembourg and Italy, in the inter war years.

The line was an exact replica of the Trench warfare and an emblem of the static battle plans that had characterised the First World War — from Verdun to Somme, Flanders or Passchendaele.

French military experts hailed it as the work of a genius. Indeed, the war broke out in 1939 and in May 1940, the French army was shocked to realise how useless the Maginot line was. Millions of German soldiers and hundreds of Panzers burst through the Ardennes forests in the south, considered impassable, in a lighting attack that completely bypassed the Maginot line, racing through to the beaches of Dunkirk, slicing France in two, inside six weeks!

The War would redefine military strategy forever, from static to mobile warfare. The lesson in strategic planning is that, always focus must be on the core, without, of course, ignoring important other ancillaries.

Currency is only viable when the public has trust or complete faith and confidence in the money. What people have faith in; that is money. For this reason, the cigarettes supplied by Allied soldiers in Germany after the Second World War briefly became a form of currency, because of the widespread acceptability by the public.

That is why overly amplified focus on the support pillars like gold, important as they are; they, per se, do not provide a guarantee for success of a currency.

Equivalently, the public confidence in the currency did not just evaporate in a single day. As such, what needs to be done to restore confidence can also not just emerge overnight — but must be painstakingly, thoroughly and meticulously thought through, at all times avoiding experiments.

That is why it is not possible for Authorities to say, overnight: “We now have US$2 billion dollars as foreign currency and on the back of that, we are now ready to introduce new currency”. No. The economy really functions perhaps differently. If only it was that simple.

The proposal for a gold/commodity backed currency is the least likely to be successful. Do we really want to take this country to a system that was in use in the 1870s — the middle of the 19th century and briefly adopted in some modified version at Bretton Woods in 1944.

It has several pitfalls and serious downside risks for the economy. It is important to interrogate whether it is optimal for monetary policy to be determined by the amount of gold or FX reserves of the country, regardless of the prevailing domestic conditions.

Do we really want domestic money supply and therefore credit availability to be a function of the value of gold reserves?

If for some reason, the Americans or Chinese decide to offload their gold and the price of gold plummets, net foreign assets on the RBZ balance sheet tank and with it, an unplanned tightening of monetary policy.

So the cost of credit goes up, growth slows, companies scale down and jobs are lost in Zimbabwe, purely because the price of gold or gold output has nosedived.

Do we really want the domestic economic policy to be so beholden to external factors, and so exogenously determined? I doubt.

For what merits? In any event, how does the accumulation of gold (important as it is) at the Central Bank, convince a widow/widower in Nyamandhlovu or Nyatate that the fiat paper she/he holds as money is infact backed by gold? She/he still has to depend on what the Government or Monetary Authorities say, and we are back to the same page on the urgent need to restore trust/confidence in currency, which is a derived institutional mechanisms trust.

Andre Maginot

The world over, only one country, Lebanon remains on some form of gold standard. No other country has considered this as a serious alternative, notwithstanding the flaws in the current fiat money, since President Nixon de-merged the US dollar from gold in 1971 and floated the US dollar.

Strong currencies, the world over remain strong on the basis of sound fundamentals that adhere to sound money. Since inception in 1948, until conversion to the Euro, the German Deutsche Mark (D-mark) was famed for its stability and acceptability the world over, not because the Bundesbank had gold to back it (though they had some gold) but because of the concrete institutional mechanisms that made the stability of the currency foolproof.

It may be important to remember that the UK Government abandoned the gold standard in 1931, at the height of the Great Depression, and other countries eventually followed suit.

The revaluation of the pound and pegging to gold had contributed measurably to the Great Depression and to Britain’s interwar industrial decline. John Keynes, the father of modern macroeconomics contented with the Chancellor of the UK Exchequer in the mid 1920s (before the great Depression), against both the revaluation of the currency and pegging it to gold.

Many economists attribute the pronounced British industrial decline in the interwar years to the revaluation of the currency and its pegging to gold.

The point is this: Having huge gold or FX reserves, important as it is, is no guarantee for acceptability and stability of the currency. Fundamentals are critical.

This is particularly in light of the fact that the global financial system literally takes no prisoners and if the tide turns against a currency, no amount of FX reserves can stand against the tide (unless you are China and sitting on US$4 trillion in FX reserves). No other country can stand the tide of global international financial markets.

So Zimbabwe must, of course accumulate gold and FX reserves, but not as a foundational/fundamental pre-requisite for currency stability.

What then is fundamental for successful currency introduction? The list below may not be completely exhaustive but forms among the core requirements to ensure currency stability.

Control of the budget deficit and financing

The most important and critical requirement for currency stability relates to control of the budget deficit and the nature of budget deficit financing.

Currency stability is fundamentally, a function of the levels of the budget deficit and how the budget deficit financing. Large and recurring budget deficits, financed through monetization, the outcome is as certain as the sun rising from the east.

In the case for Zimbabwe, because of the experience with large fiscal deficits, recurrently monetised, it becomes an imperative not just to control the budget deficit but even target some small surplus as a way of building and restoring fiscal credibility. It is the road less travelled.

Stabilising inflation at levels consistent with currency stability is impossible without control of the budget deficit and financing. Achievement and sustaining price stability requires sustaining low fiscal deficits and prudence in the financing of such deficits.

Confidence Instalment:

Reverting to cash budgeting

As part of efforts to gain control of the fiscal budget and as much to reinforce the message that the budget deficit is completely under control, it may be important to consider cash budgeting for 2 or 3 years prior to introduction of the domestic currency.

Coupled with targeted fiscal surplus (the budget permitting), this may be an important and powerful signal by Authorities that the budget is completely under control.

The public will observe such bold steps and interpret that to mean that Authorities are firmly in control of the fiscus. Such a step will also increase demand on Government instruments such as Treasury Bills, lowering interest rates in the economy.

Even if the cash budgeting is adopted in some modified version, what is important is the concrete steps to control the budget deficit, the elephant in the room.

Domestic and Foreign Debt Resolution

Zimbabwe is, unsustainably saddled by both domestic and foreign debt. As part of overall macroeconomic reforms, there is need to address this problem, comprehensively, beginning with multilateral debt under a structured repayment arrangement.

The resolution of domestic debt is directly linked to the financing of the budget deficit and has implications on the banking sector stability and financial/capital markets development. This is critically important for currency stability.

Joseph Mverecha is an Economist with a Local Commercial Bank and writes in his own capacity.